oversight

Defense Restructuring Costs: Information Pertaining to Five Business Combinations

Published by the Government Accountability Office on 1997-04-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Office

GAO               Report to Congressional Committees




April 1997
                  DEFENSE
                  RESTRUCTURING
                  COSTS
                  Information Pertaining to
                  Five Business
                  Combinations




GAO/NSIAD-97-97
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      National Security and
      International Affairs Division

      B-276318

      April 1, 1997

      The Honorable Ted Stevens
      Chairman
      The Honorable Daniel K. Inouye
      Ranking Minority Member
      Subcommittee on Defense
      Committee on Appropriations
      United States Senate

      The Honorable C. W. Bill Young
      Chairman
      The Honorable John P. Murtha
      Ranking Minority Member
      Subcommittee on National Security
      Committee on Appropriations
      House of Representatives

      Section 8115 of the Fiscal Year 1997 Department of Defense (DOD)
      Appropriations Act1 requires us to examine restructuring costs2 of defense
      contractors involved in business combinations since 1993. In response,
      this report provides information on restructuring costs, including specific
      costs associated with workforce reductions and the services provided to
      workers affected by business combinations. It also identifies other funds
      used to help laid-off workers find new employment and describes why the
      effectiveness of restructuring costs used to assist laid-off workers in
      gaining new employment cannot be determined. In addition, the report
      discusses the extent of savings achieved from the business combinations
      relative to restructuring costs paid by DOD.

      To accomplish our work, we focused on five defense contractor business
      combinations: (1) Hughes Aircraft Company’s acquisition of General
      Dynamics Corporation’s Missile Operations, (2) the United Defense
      Limited Partnership (UDLP) between FMC Corporation’s Defense Systems
      Group and Harsco Corporation’s BMY Combat Systems Division,
      (3) Martin Marietta Corporation’s acquisition of General Electric
      Company’s aerospace and other business segments, (4) Northrop
      Corporation’s acquisitions of the Grumman Corporation and the Vought
      Aircraft Company to form the Northrop Grumman Corporation, and

      1
       Public Law 104-208, September 30, 1996.
      2
       Restructuring costs cover a wide range of expenses, such as personnel relocations, severance pay,
      early retirement incentives, equipment relocations, plant rearrangements, and facility closures.



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                   (5) the merger of the Lockheed Corporation and the Martin Marietta
                   Corporation to form the Lockheed Martin Corporation.


                   The five business combinations had spent about $849 million at the time of
Results in Brief   our review for such restructuring activities as the disposal and relocation
                   of facilities and equipment, consolidation of operations and systems,
                   employee relocation, and workforce reductions. Of this amount, the
                   business combinations spent about $89 million, or 10 percent, on
                   workforce reductions, which consisted of severance pay, temporary
                   continuation of health benefits, and outplacement services. About
                   15,000 workers left the companies as a result of the business
                   combinations. Severance pay represented about 89 percent of total worker
                   benefits. Expenditures for services to assist laid-off workers find
                   reemployment totaled $4 million.

                   In addition to those services provided from restructuring costs, we
                   identified about $48 million in Department of Labor (DOL) grants made
                   either directly to the contractors or to locations where workers were laid
                   off as a result of the business combinations or normal downsizing.
                   Moreover, there were at least 163 federally funded programs and funding
                   streams that provided employment training assistance, of which 9 are
                   targeted specifically for laid-off workers. During fiscal year 1996, funding
                   for one of the nine programs totaled about $1.1 billion; however, no readily
                   available means exist to determine the extent to which the majority of
                   these funds, which are distributed at the state and local levels, were used
                   to assist workers affected by the five business combinations. The business
                   combinations were also providing some services that were not included in
                   restructuring costs, but rather were paid as normal overhead costs.

                   We were unable to determine the effectiveness of services for workers laid
                   off specifically as a result of the business combinations because
                   information critical to making such a determination—including
                   reemployment rates, workers’ previous and current salaries, and
                   satisfaction with their new jobs—are not maintained by the business
                   combinations and are not readily available from other sources. In general,
                   little empirical information is available on specific services that are the
                   most useful and cost-effective.

                   The Defense Contract Audit Agency (DCAA) estimated that, as of
                   September 30, 1996, DOD had reimbursed these business combinations
                   about $179 million toward its share of the $849 million the combinations



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             had incurred for restructuring activities. DCAA also estimated that DOD
             realized restructuring savings totaling $347 million from the business
             combinations during the same period. Therefore, for every $1.00 DOD has
             paid so far in restructuring costs, DOD has realized savings of $1.93. DOD
             officials believe that additional savings have been realized, but they did
             not document those savings. An industry representative also commented
             that these estimates cover only the period through September 1996, and
             therefore, do not reflect savings that may be realized in future periods. It
             should be noted, however, that the estimates also do not reflect any costs
             that may be incurred in subsequent periods. Finally, these estimates do not
             reflect DOL grant expenditures or any assistance from other federal
             programs or funding streams.

             Of the $179 million paid to the business combinations, DCAA determined
             that $18 million, or about 10 percent, represented additional costs to DOD
             as a result of the July 1993 decision to pay for restructuring costs on
             certain contracts transferred from one company to another after a
             business combination. The percentage of additional costs relative to the
             total amount paid may not be the same for future business combinations.


             Prior to July 1993, DOD had a long-standing practice of not permitting
Background   defense contractors to charge restructuring costs to flexibly priced3
             contracts that were transferred4 from one contractor to another as a result
             of a business combination. The rationale for this practice was that DOD
             should not have to pay increased costs merely because one contractor is
             combined with another contractor.

             In July 1993, DOD changed its long-standing practice and uniformly began
             permitting defense contractors to charge restructuring costs to transferred
             flexibly priced contracts after a business combination, provided (1) the
             restructuring costs were allowable under the Federal Acquisition
             Regulation (FAR)5 and (2) a DOD contracting officer determined the
             business combination would result in overall reduced costs to DOD or
             preserve a critical defense capability. According to DOD officials, this

             3
              Flexibly priced contracts are a family of contracts under which the total amount paid to the
             contractor is dependent on the allowable costs the contractor incurs in performing the contract.
             4
              The transfer of contracts from one contractor to another involves a process called novation. The
             novation process requires a written agreement executed by the seller, buyer, and government, in which
             the government agrees to the transfer of its contracts.
             5
              The FAR contains guidelines for determining whether a particular restructuring cost is an allowable
             charge to a government contract. It also describes certain organization costs, such as legal and
             consulting fees applicable to business combinations, that cannot be charged to a government contract.



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action was consistent with the flexibility provided by federal regulations.
However, when asked, DOD officials stated that they were unaware of any
instances where DOD had previously allowed restructuring costs to be
charged to transferred contracts.

As a result of its concerns over the payment of these costs, the Congress
enacted section 818 of the National Defense Authorization Act for Fiscal
Year 1995,6 which prohibited payment of restructuring costs to a defense
contractor until a senior DOD official certified that projections of
restructuring savings from the business combinations were based on
audited cost data and should result in overall reduced costs to DOD.
Section 818 also required the Secretary of Defense to report to the
Congress on DOD’s experience with defense contractor business
combinations, including whether savings associated with each
restructuring actually exceed restructuring costs.7

The Congress modified authority for paying restructuring costs in section
8115 of the Department of Defense Appropriations Act for Fiscal Year 1997
by prohibiting payment of those costs for business combinations occurring
after September 30, 1996, unless (1) restructuring savings for DOD were
projected to exceed allowed costs by a factor of at least two to one or
(2) the projected savings to DOD exceeded the costs allowed and the
Secretary of Defense determined the business combination would result in
the preservation of a critical capability, and (3) the DOD restructuring
report for 1996 was submitted.

As of December 31, 1996, the Under Secretary of Defense (Acquisition and
Technology) had certified five business combinations for restructuring
payments.8 Table 1 shows the certification dates for the business
combinations in our review. We also included in our review the
Hughes-General Dynamics business combination because DOD has
included the combination in its restructuring reports to the Congress.
However, the Hughes-General Dynamics combination did not go through
the certification process because the combination occurred prior to
enactment of the Defense Authorization Act for Fiscal Year 1995.

6
 Public Law 103-337, October 5, 1994.
7
 Section 818 required DOD to submit reports to the Congress on defense contractor restructuring
activities for fiscal years 1995, 1996, and 1997. DOD transmitted the required reports for fiscal years
1995 and 1996 on June 18 and December 23, 1996, respectively. We subsequently refer to these reports
as DOD restructuring reports.
8
 We examined four of the five certified business combinations. We did not examine Martin Marietta
Corporation’s acquisition of General Dynamics Corporation’s Space System Division because we were
already examining two other business combinations involving Martin Marietta Corporation.



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Table 1: Business Combination
Certification Dates             Business combination                                     Date certified
                                UDLP                                                     May 15, 1995
                                Martin Marietta-General Electric:a
                                      5 projects                                         September 19, 1995
                                      3 projects                                         February 14, 1996
                                      5 projects                                         September 17, 1996
                                Northrop Grumman                                         February 14, 1996
                                Lockheed Martinb                                         November 26, 1996
                                a
                                    One additional project is nearing certification.
                                b
                                    Additional projects are expected to enter the certification process.



                                The Defense Contract Management Command (DCMC) has lead
                                responsibility for implementing DOD’s restructuring regulations. According
                                to DCMC officials, they are tracking an additional 10 defense contractor
                                business combinations that are currently in or expected to enter the
                                various stages of the certification process.


                                For the five business combinations we examined, certified restructuring
Restructuring Costs             costs totaled about $1.4 billion. At the time of our review, the companies
                                had spent about $849 million (see table 2). To reflect the uncertainty in the
                                cost estimates and reduce the need for recertification if the costs
                                increased, ceilings ranging from 104 percent to 142 percent of certified
                                costs were established for the restructuring projects. The contractors will
                                not be permitted to charge DOD costs in excess of the portion of these
                                ceilings applicable to DOD.9




                                9
                                 Restructuring costs and cost ceilings are allocated to all of a contractor’s customers. DOD’s portion of
                                restructuring costs and ceilings, therefore, depends on its share of the contractor’s total business base.



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Table 2: Certified Costs, Cost Ceilings,
and Incurred Cost, by Business             Dollars in millions
Combination                                Business combination                               Certified             Ceiling         Incurred
                                                                                                        a
                                           Hughes-General Dynamics                              $366.1               $370.0           $327.3
                                           UDLP                                                    36.4                 38.0              38.6
                                           Martin Marietta-General Electric                       214.5               226.3             193.4
                                           Northrop Grumman                                        70.4               100.1               75.1b
                                           Lockheed Martin                                        686.5               724.0             214.9
                                           Total                                              $1,373.9             $1,458.4c          $849.3
                                           a
                                            Certified costs for the Hughes-General Dynamics combination are estimated rather than certified
                                           because the business combination was not subject to the certification process.
                                           b
                                            Incurred costs for the Northrop Grumman combination include an estimate of cost-to-complete
                                           the restructuring.
                                           c
                                           DOD indicated that its projected share of the cost ceiling totaled $809.3 million.



                                           Restructuring after a business combination includes a wide range of
                                           activities, such as the disposal and modification of facilities, consolidation
                                           of operations and systems, relocation of workers and equipment, and
                                           workforce reductions. We grouped incurred restructuring costs for the
                                           five business combinations into broad categories (see table 3). Disposal
                                           and relocation of facilities and equipment was the largest category of total
                                           incurred restructuring costs.

Table 3: Incurred Restructuring Costs
by Category                                Dollars in millions
                                           Category                                                                                 Incurred
                                           Disposal and relocation of facilities and equipment                                        $452.7
                                           Relocation of employees                                                                      100.0
                                           Benefits and services for laid-off workers                                                     88.9
                                           Consolidation of operations and systems                                                        81.4
                                           Restructuring planning and implementation                                                      57.8
                                           Other                                                                                          68.5
                                           Total                                                                                      $849.3



                                           In total, the five companies projected that about 19,000 workers would
Costs Associated With                      leave as a result of the business combinations and, at the time of our
Workforce Reductions                       review, about 15,000 had left (see table 4).




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Table 4: Projected and Actual Number
of Workers Leaving Organizations as a   Business combination                                          Projected                      Actual
Result of the Business Combination      Hughes-General Dynamics                                            6,600                      6,441
                                        UDLP                                                                 483                       500
                                        Martin Marietta-General Electric                                   1,171                      1,222
                                        Northrop Grumman                                                     450                       450
                                        Lockheed Martin                                                   10,678                      6,312a
                                        Total                                                             19,382                     14,925
                                        a
                                        This number will increase as Lockheed Martin completes its planned restructuring projects.



                                        The wide variation in the number of job losses reflects differences in the
                                        nature of the restructurings. For instance, Northrop Grumman’s largest
                                        restructuring project involved closing the former Grumman corporate
                                        headquarters in Bethpage, New York, resulting in the loss of about
                                        250 employees. By contrast, the Lockheed Martin restructuring involved
                                        closing facilities in New Jersey, Pennsylvania, and Texas, and
                                        consolidating various launch operations, radar and microwave operations,
                                        and corporate laboratories.

                                        Of the nearly $1.4 billion in projected restructuring costs, the five business
                                        combinations estimated they would spend about $175 million for benefits
                                        associated with workforce reductions. The costs included severance pay,
                                        temporary continuation of health benefits, and outplacement services. The
                                        estimated costs for worker benefits and services varied among the
                                        combinations, ranging from 8.6 percent to 23.9 percent of total certified
                                        restructuring costs as shown by table 5.

Table 5: Estimated Costs for Benefits
and Services for Laid-Off Workers by    Dollars in millions
Business Combination                                                                        Total      Estimated costs
                                                                                         certified     for benefits and
                                        Business combination                               costs              services           Percent
                                        Hughes-General Dynamics                            $366.1                   $31.5               8.6
                                        UDLP                                                  36.4                    8.7              23.9
                                        Martin Marietta-General Electric                    214.5                    24.0              11.2
                                        Northrop Grumman                                      70.4                    9.3              13.2
                                        Lockheed Martin                                     686.5                   101.1              14.7
                                        Total                                            $1,373.9                  $174.6              12.7

                                        Of the $849.3 million already incurred for restructuring costs, the five
                                        contractors had expended $88.9 million, or about 10 percent, for benefits



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                                        and services for workers that left the corporations because of the business
                                        combinations (see table 6). However, Lockheed Martin has not completed
                                        its restructuring activities. Some of these activities are projected to involve
                                        additional workforce reductions, which will lead to additional severance
                                        and outplacement costs.

Table 6: Incurred Costs for Worker
Benefits and Services by Business       Dollars in millions
Combination                                                                       Total     Costs incurred
                                                                               incurred    for benefits and
                                        Business combination                      costs           services       Percent
                                        Hughes-General Dynamics                  $327.3              $31.3            9.6
                                        UDLP                                       38.6                 5.3         13.7
                                        Martin Marietta-General Electric          193.4               22.5          11.6
                                        Northrop Grumman                           75.1                 8.8         11.7
                                        Lockheed Martin                           214.9               21.0            9.8
                                        Total                                    $849.3              $88.9          10.5

                                        Severance pay was by far the largest worker benefit and comprised about
                                        88 percent and 89 percent of the estimated and incurred costs for worker
                                        benefits and services, respectively (see table 7). Each of the five business
                                        combinations provided severance pay to workers, and four provided for
                                        the temporary continuation of health benefits and other services to assist
                                        laid-off workers find new employment.

Table 7: Costs Associated With Worker
Benefits and Services by Category       Dollars in millions
                                        Benefit or service                                      Estimated       Incurred
                                        Severance pay                                               $153.3         $79.5
                                        Continuation of health benefits                               13.4            5.6
                                        Reemployment assistance                                         7.8           4.0
                                             a
                                        Total                                                       $174.5         $88.9
                                        a
                                        Totals may not add due to rounding.



                                        Severance pay varied with such factors as whether the workers were
                                        salaried or hourly employees and the length of time they had been with the
                                        corporations. Additional differences were the result of the individual
                                        contractor’s worker benefit packages before the business combinations.
                                        For example, in the Hughes-General Dynamics combination, former
                                        Hughes workers received severance pay, but former General Dynamics
                                        workers did not. Also, neither the Northrop nor Vought Corporations had



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                                        severance benefits for its workers, but the Grumman Corporation did.
                                        After the business combination, therefore, former Northrop and Vought
                                        workers received no severance benefits, but former Grumman workers
                                        received the severance benefits they would have received had there been
                                        no business combination.


                                        The four business combinations that provided services to help workers
Services Provided to                    laid off find new employment estimated they would spend $7.8 million for
Assist Laid-Off                         such services. At the time of our review, the four companies had expended
Workers Find New                        $4 million for these services (see table 8). The cost of these services
                                        represents less than 1 percent of both the total certified and incurred
Employment                              restructuring costs.

Table 8: Costs for Services to Assist
Laid-Off Workers Find New               Dollars in millions
Employment by Business Combination      Business combination                                   Estimated       Incurred
                                        Hughes-General Dynamics                                      $1.0          $1.0
                                        UDLP                                                          0.7            0.2
                                        Martin Marietta-General Electric                              1.4            1.6
                                        Northrop Grumman                                                0             0
                                        Lockheed Martin                                               4.7            1.2
                                        Total                                                        $7.8          $4.0

                                        The services provided to help laid-off workers find new employment fell
                                        into two categories—educational and outplacement services (see table 9).
                                        In the Martin Marietta-General Electric business combination, retraining
                                        services were provided in accordance with the General Electric layoff
                                        benefits plan. Under plant closing provisions, all former General Electric
                                        employees were eligible for up to $5,000 tuition reimbursement for any
                                        licensed or accredited occupational or educational courses up to 3 years
                                        from the date of layoff. There was a requirement, however, that an
                                        employee start at least one course within the first year after layoff. Former
                                        Hughes employees were also provided educational benefits up to $5,000
                                        for attendance at an accredited college or university and the successful
                                        completion of classes that started within 1 year of the time the worker was
                                        laid off.




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Table 9: Cost of Services to Help
Workers Find New Employment by      Dollars in millions
Category                            Benefit or service                                                  Estimated         Incurred
                                    Retraining and educational assistance                                      $2.0             $1.7
                                    Outplacement services                                                       5.8              2.3
                                    Total                                                                      $7.8             $4.0

                                    In addition to providing educational assistance, Martin Marietta also
                                    provided various outplacement services. As a result of a plant closing at
                                    Bridgeport, New Jersey, for example, Martin Marietta operated an on-site
                                    employment transition center for a 9-month period in 1994. Designed to
                                    serve 392 employees affected by the plant closing, the center provided
                                    career transition workshops, resume development, telephone and
                                    interviewing skill practice, salary negotiations, career counseling, job
                                    support groups, and job fairs. Martin Marietta incurred about $326,000 in
                                    restructuring costs to operate the center. Martin Marietta established a
                                    similar center to assist workers affected by the closing of a facility in
                                    Conklin, New York. Restructuring costs for this center amounted to
                                    $177,000, which included the salary costs for the center’s director and
                                    counselor, equipment rentals, and telephone expenses.


                                    In addition to services being paid through restructuring costs, services
Other Funds Used to                 were also funded by DOL grants and through normal overhead charges at
Assist Laid-Off                     the business combinations. Services funded by DOL were available to
Workers Find New                    laid-off workers regardless of whether they were terminated as a result of
                                    a defense contractor business combination or normal downsizing, and
Employment                          some services were made available to workers from other companies.
                                    However, neither DOL, the business combinations, nor the grant recipients
                                    maintained records showing how many workers who used these services
                                    were terminated as a result of the combination.


Services Funded by DOL              Many federally funded programs exist to assist laid-off workers find new
Grants                              employment. We reported, for example, in February 1995 that at least
                                    163 federally funded programs and funding streams existed that provided
                                    employment training assistance, of which 9 are targeted specifically for
                                    laid-off workers.10 Among the most significant programs are those
                                    authorized by the Economic Dislocation and Worker Adjustment

                                    10
                                     Multiple Employment Training Programs: Major Overhaul Needed to Create a More Efficient,
                                    Customer-Driven System (GAO/T-HEHS-95-70, Feb. 6, 1995) and Multiple Employment Training
                                    Programs: Information Crosswalk on 163 Employment Training Programs (GAO/HEHS-95-85FS,
                                    Feb. 14, 1995).



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Assistance (EDWAA) Act. In total, the Congress appropriated about
$1.1 billion in fiscal year 1996 EDWAA grants to help dislocated workers.
Funds provided under EDWAA are allocated by a formula in which
80 percent of the appropriated funds are provided directly to the states,
with the remaining 20 percent reserved for the Secretary’s discretion. The
discretionary funds may be awarded to projects for workers dislocated
due to mass layoffs, plant closures, disasters, and federal government
actions.

In addition, the Congress appropriated $150 million in fiscal year 1991 for
Defense Conversion Adjustment Program (DCAP) grants, which are
available to address the training and employment needs of workers
dislocated by defense downsizing, including consolidation actions
subsequent to cutbacks in defense budgets. DCAP grants can be awarded to
states or directly to defense contractors. The Congress also appropriated
$75 million in fiscal year 1993 for Defense Diversification Program (DDP)
grants to provide training, adjustment assistance, and employment
services to members of the armed forces and DOD and defense contractor
employees who were either involuntarily separated or laid off as a result
of reductions in defense spending.

DOL  officials told us they do not collect information on whether EDWAA,
DCAP,  or DDP funds were used to assist workers specifically laid off as a
result of defense contractor business combinations. These officials
indicated that some grant requests contain information that may make it
possible to relate the layoffs to specific factors such as plant closings.
However, they noted that service providers are not required to maintain
information or report on the reasons why the workers were laid off. These
officials acknowledged that because defense contractor business
combinations can result from decreases in defense spending, some of the
funds may have been used to assist workers dislocated as a result of these
business combinations.

We identified about $48 million in discretionary, DCAP, or DDP grants made
either directly to defense contractors involved in the business
combinations or to locations affected by those combinations. DOL awarded
Hughes two grants totaling $16 million to assist workers affected by
downsizing in southern California, and another two grants totaling
$1.2 million to Martin Marietta to assist workers in central Florida.
Another 10 grants—totaling about $31.1 million—were awarded to 8 states
that were affected by restructuring activities of the business combinations.
Three of these grants, totaling $21 million, were targeted to assist a group



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                          of 22 defense and defense-related companies or facilities in southern
                          California, including Northrop Grumman. A New York grant, totaling
                          about $5.3 million, was targeted to assist former Grumman employees.
                          Various outplacement services were provided under these grants,
                          including vocational and career guidance, job search assistance, and basic
                          skills training.

                          Although the amount of grant funds are significant for the five business
                          combinations we examined, DOD’s guidance for preparation of the annual
                          reports to the Congress on defense contractor restructuring activities does
                          not require reporting any information on DOL grants. Because these grants
                          are related to defense contractor restructuring activities, including grant
                          information in the reports—especially on those grants made directly to
                          contractors—would give the Congress useful information on funding
                          available to assist workers affected by defense contractor business
                          combinations.


Services Funded Through   Several of the business combinations operated outplacement facilities
Contractor Overhead       where workers could obtain assistance in finding new employment and
                          charged the operational costs to overhead expenses rather than
                          restructuring costs. For example, UDLP operated a center during the period
                          1994 through 1996 and all terminated employees—regardless of whether
                          they were laid off as a result of the business combination or normal
                          downsizing—could obtain assistance at the center in writing resumes,
                          arranging for job interviews, reviewing job listings, and other related
                          outplacement services. UDLP expended $205,000 in operating this center
                          during the 3-year period and paid an additional $109,000 to a consulting
                          firm to assist middle- and senior-level management officials find new
                          employment. UDLP charged these costs to overhead rather than
                          restructuring costs. Similarly, Northrop Grumman and Lockheed Martin
                          also provided counseling and/or outplacement assistance to help workers
                          find new employment and charged the costs to overhead expenses rather
                          than restructuring costs.




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                       We were unable to determine the effectiveness of the services provided to
Effectiveness of       help laid-off workers find new employment. Like most organizations, the
Services Provided to   five business combinations we examined did not have a comprehensive
Help Terminated        system in place to evaluate outplacement effectiveness. Officials cited
                       various difficulties that prevent them from implementing such a system.
Workers Find New       Similarly, information needed to determine the effectiveness of these
Employment Could       services is not readily available from DOL.
Not Be Determined      Two basic elements are required in a comprehensive system for assessing
                       the effectiveness of outplacement services: (1) criteria against which to
                       make the assessment and (2) a tracking system to collect relevant
                       performance information. Our work and work by DOL shows that most
                       organizations do not evaluate outplacement services in terms of such
                       criteria as whether those who received services are reemployed faster,
                       received higher salaries, or were more satisfied with the jobs they found
                       than a control group of those individuals who did not receive such
                       assistance.11 Participants at a recent workshop conducted by the Office of
                       the Deputy Assistant Secretary of Defense (Civilian Personnel Policy) and
                       the National Academy of Sciences concluded that no empirical work has
                       been able to identify the aspects of outplacement programs that are the
                       most cost-effective and useful in terms of these criteria.12

                       The business combinations we examined did not have a comprehensive
                       system in place to track the effectiveness of services they provided to
                       laid-off workers. Officials from Lockheed Martin, for example, told us that
                       comprehensive tracking is difficult, especially in cases of a plant closure
                       as there would then be no company representative on location to do the
                       tracking. In addition, some laid-off workers do not want further contact
                       with their former employer, making tracking difficult. Officials noted,
                       moreover, that former employees have no obligation or incentive to report
                       information regarding their subsequent employment status or salary
                       information.

                       Similarly, information needed to determine the effectiveness of services
                       provided to workers laid off as a result of the business combinations is not

                       11
                        Multiple Employment Training Programs: Most Federal Agencies Do Not Know If Their Programs Are
                       Working Effectively (GAO/HEHS-94-88, Mar. 2, 1994); Multiple Employment Training Programs: Major
                       Overhaul Needed to Reduce Costs, Streamline the Bureaucracy, and Improve Results
                       (GAO/T-HEHS-95-53, Jan. 10, 1995); Workforce Reductions: Downsizing Strategies Used in Selected
                       Organizations (GAO/GGD-95-54, Mar. 13, 1995); Employment Training: Successful Projects Share
                       Common Strategies (GAO/HEHS-96-108, May 7, 1996); and A Guide to Well-Developed Services for
                       Dislocated Workers, U.S. Department of Labor, Employment and Training Administration.
                       12
                        Issues in Civilian Outplacement Strategies: Proceedings of a Workshop, National Academy Press,
                       Washington, D.C., 1996.



                       Page 13                                         GAO/NSIAD-97-97 Defense Restructuring Costs
                      B-276318




                      readily available from DOL. DOL does not collect certain critical information,
                      such as participant satisfaction with the position obtained or the relative
                      success of control groups who do not participate in the programs. DOL
                      officials stated that they did maintain information that reflects various
                      measures of the effectiveness of DOL-funded programs at the aggregate
                      level, such as whether program participants obtained a new position and
                      participants’ average wages before and after receiving the services. DOL
                      officials expressed concern, however, about using their data, noting that
                      the service providers do not always submit accurate or complete
                      information. Finally, these officials noted that they could not provide
                      information pertaining specifically to any of the business combinations in
                      our review.


                      Defense contractors are required to maintain accounting records showing
Comparing             the actual amount and nature of costs charged to government contracts.
Restructuring Costs   These costs are generally billed to government contracts during the same
and Estimated         period they are incurred. As discussed earlier, however, the section 818
                      prohibition against payment of restructuring costs until certification of net
Savings               savings creates a requirement for the contractor to segregate restructuring
                      costs in its accounting records and to exclude these costs from any
                      billings, final contract price settlements, and overhead settlements until
                      the certification is made. After the certification, the contractor is then
                      permitted to begin charging restructuring costs to DOD contracts. The
                      contractor generally recovers restructuring costs over a 5-year period but
                      the recoupment period may be shorter, depending on the terms of the
                      advance agreement negotiated between DOD and the contractor.

                      Restructuring savings, on the other hand, are not recorded in a
                      contractor’s accounting records. Therefore, neither the amount nor the
                      nature of the savings can be determined by reviewing the accounting
                      records. Consequently, savings have to be estimated. For example,
                      Northrop Grumman estimated 5-year savings from closing the Grumman
                      corporate headquarters of about $215 million, of which about $100 million
                      represents the labor and fringe costs that would be avoided over the 5-year
                      period by laying off approximately 250 workers. These savings are
                      therefore an estimate of a cost avoidance over the 5 years—the costs of the
                      additional people that would have been needed had the headquarters not
                      been closed. Savings from restructuring activities we examined were
                      generally in the form of such future cost avoidances.




                      Page 14                               GAO/NSIAD-97-97 Defense Restructuring Costs
                                      B-276318




                                      The initial estimate of restructuring savings is simple in concept because it
                                      makes the critical assumption that everything else, except for the
                                      restructuring, is the same after a business combination as before. Because
                                      things are never the same, it is difficult to precisely identify actual savings
                                      several years after the initial estimate is prepared. The December 1996 DOD
                                      restructuring report acknowledges this problem. It points out that
                                      restructuring is not the only factor that has an impact on actual costs.
                                      Other factors affecting costs include changes in the rate of inflation,
                                      fluctuations in the business base, and subsequent reorganizations.

                                      At the request of DCMC, DCAA did a study of the estimated amount of
                                      restructuring costs paid and the estimated amount of savings realized as of
                                      September 30, 1996, for the business combinations for which DOD had
                                      allowed restructuring costs. DCAA estimated that DOD had paid
                                      $179.2 million in restructuring costs and realized estimated restructuring
                                      savings of $346.7 million as of September 30, 1996, for a net savings of
                                      $167.5 million (see table 10).

Table 10: Estimates of Paid
Restructuring Costs and Experienced   Dollars in millions
Savings by Business Combination                                                                               Experienced
                                      Business combinationa                                   Paid costs          savings      Net savings
                                                                       b
                                      Hughes-General Dynamics                                      $124.3            $147.9                $23.6
                                      UDLP                                                              9.9             22.9                13.0
                                                                            c
                                      Martin Marietta-General Electric                                36.7            108.2                 71.5
                                      Northrop Grummand                                                 8.3             67.7                59.4
                                      Total                                                        $179.2            $346.7           $167.5
                                      a
                                       Lockheed Martin was not included in the DCAA study because it was certified after
                                      September 30, 1996.
                                      b
                                          Represents savings on only eight contracts.
                                      c
                                       Represents restructuring costs and savings from the first eight certified restructuring projects.
                                      DCAA did not project costs and savings for the five projects certified on September 17, 1996,
                                      because actual experience through September 30, 1996, would have been minimal.
                                      d
                                       Estimated savings are based on two of the six projects certified. These two projects accounted
                                      for 90 percent of total projected savings.



                                      Measured another way, the figures shown in table 10 indicate that DOD has
                                      realized $1.93 in savings for each $1.00 of restructuring cost paid. DOD
                                      officials acknowledged that while their estimates reflect $1.93 in savings
                                      for each dollar reimbursed, they believed additional savings were being
                                      realized. They explained that DOD had based its estimate of savings for the




                                      Page 15                                            GAO/NSIAD-97-97 Defense Restructuring Costs
                     B-276318




                     Hughes-General Dynamics business combination on only eight contracts
                     that demonstrated savings in excess of costs. They noted that
                     documenting higher savings was not considered a prudent use of
                     resources. An industry representative also commented that the estimates
                     covered only the period through September 1996 and therefore do not
                     consider savings that may be realized in future periods. It should be noted
                     that the estimates in table 10 also do not reflect any costs that may be
                     incurred in subsequent periods. Finally, the estimates do not reflect DOL
                     grant expenditures or any assistance from the other federal programs or
                     funding streams.

                     Of the $179.2 million DOD has paid to these four business combinations for
                     restructuring costs, DCAA determined that $18 million, or about 10 percent,
                     was charged to novated flexibly priced contracts. The $18 million,
                     therefore, represents the amount of additional costs to DOD as a result of
                     its decision in July 1993 to allow contractors to charge restructuring costs
                     to novated flexibly priced contracts. It should be noted that the 10 percent
                     in additional costs for these four business combinations may not be
                     representative of the percentage for future business combinations because
                     of differences in factors that determine the percentage, including the mix
                     of flexibly priced and firm fixed-price contracts and the period of time
                     required for certification.


                     Because direct federal grant funds can be substantial, as in the
Recommendation       Hughes-General Dynamics and Martin Marietta-General Electric business
                     combinations, we recommend that the Secretary of Defense obtain
                     information about significant federal direct grants to defense contractors
                     involved in business combinations and include this information in the DOD
                     annual restructuring reports to the Congress. Such information could
                     include the grants’ dollar values, purposes, and periods of performance.


                     In commenting on a draft of this report, DOD generally concurred. DOD
Agency Comments      suggested several technical clarifications, and we have incorporated them
and Our Evaluation   in the text where appropriate. DOD’s comments are presented in its entirety
                     in appendix I. DOL did not indicate any overall assessment of the report,
                     but did provide several technical clarifications, which we have
                     incorporated in the text where appropriate. DOL’s comments are presented
                     in their entirety in appendix II.




                     Page 16                              GAO/NSIAD-97-97 Defense Restructuring Costs
              B-276318




              The Aerospace Industries Association (AIA) provided comments on a draft
              of this report on behalf of the business combinations we reviewed. AIA
              noted that, on balance, the report was objective. AIA offered several
              technical changes to clarify the information provided, which we have
              incorporated in the text where appropriate. AIA’s comments are provided
              in their entirety in appendix III.


              To respond to the requirements of section 8115 of Public Law 104-208, we
Scope and     selected the three business combinations for which the Under Secretary of
Methodology   Defense (Acquisition and Technology) had issued a letter of certification
              as of September 30, 1996. Two additional business combinations were
              certified by the Under Secretary of Defense (Acquisition and Technology)
              on November 26, 1996, involving the Lockheed-Martin Marietta business
              combination and Martin Marietta’s May 1994 acquisition of General
              Dynamics Corporation’s Space System Division. We included the
              Lockheed-Martin Marietta combination because of the large amount of
              restructuring costs and savings involved in this combination, but excluded
              the Martin Marietta-General Dynamics combination because we were
              already examining two other combinations involving Martin Marietta.
              While the Hughes-General Dynamics business combination did not have to
              undergo the certification process, we included it in our review because
              DOD has included the combination in its restructuring reports to the
              Congress.

              To determine the amount and nature of restructuring costs, we obtained
              information from each of the business combinations and DOD showing the
              amount and nature of certified and incurred restructuring costs at the time
              of our review. We analyzed the information provided by the business
              combinations along with DCAA audit reports and pertinent DOD and DCMC
              records to determine the amount and nature of restructuring costs
              incurred for workforce reductions and to identify the cost and nature of
              services provided to assist laid-off workers find reemployment. However,
              we did not independently verify the information provided.

              We also met with DOL officials and obtained information on federal grants
              made to assist displaced defense contractor workers find new
              employment. We reviewed files for grants awarded under the DOL
              Secretary’s discretion or under the DCAP and DDP programs that DOL
              officials identified as being targeted to locations in which restructuring
              activities were occurring. To address the issue concerning the
              effectiveness of outplacement services in assisting displaced workers find



              Page 17                             GAO/NSIAD-97-97 Defense Restructuring Costs
B-276318




reemployment, we obtained and reviewed information provided from DOL,
DOD, academia, and each of the business combinations. In assessing
restructuring savings realized from the business combinations relative to
the restructuring cost paid by DOD, we examined the methodology DCAA
used to estimate the amount of restructuring costs paid by DOD and the
amount of estimated savings. We generally found their approach and
methodology to be reasonable and relied on their work to determine the
estimated amount of savings realized and costs paid by DOD as of
September 30, 1996.

We discussed various aspects of the restructuring costs and savings with
officials from each of the business combinations, DOD, DCMC, DCAA, the DOD
Inspector General, and DOL. Additionally, we provided summaries of our
work to the contractors’ representatives to review for accuracy.

We performed our review between October 1996 and March 1997 in
accordance with generally accepted government auditing standards.


We are sending copies of this report to the Secretaries of Defense and
Labor; the Commander, DCMC; the Director, DCAA; the Director, Office of
Management and Budget; and interested congressional committees.
Copies will also be made available to others upon request.

Please contact me at (202) 512-4841 if you or your staff have any questions
concerning this report. The major contributors to this report are listed in
appendix IV.




David E. Cooper
Associate Director
Defense Acquisitions Issues




Page 18                              GAO/NSIAD-97-97 Defense Restructuring Costs
Page 19   GAO/NSIAD-97-97 Defense Restructuring Costs
Contents



Letter                                                                                              1


Appendix I                                                                                         22

Comments From the
Department of
Defense
Appendix II                                                                                        25

Comments From the
Department of Labor
Appendix III                                                                                       28

Comments From the
Aerospace Industries
Association
Appendix IV                                                                                        31

Major Contributors to
This Report
Tables                  Table 1: Business Combination Certification Dates                           5
                        Table 2: Certified Costs, Cost Ceilings, and Incurred Cost, by              6
                          Business Combination
                        Table 3: Incurred Restructuring Costs by Category                           6
                        Table 4: Projected and Actual Number of Workers Leaving                     7
                          Organizations as a Result of the Business Combination
                        Table 5: Estimated Costs for Benefits and Services for Laid-Off             7
                          Workers by Business Combination
                        Table 6: Incurred Costs for Worker Benefits and Services by                 8
                          Business Combination
                        Table 7: Costs Associated With Worker Benefits and Services by              8
                          Category
                        Table 8: Costs for Services to Assist Laid-Off Workers Find New             9
                          Employment by Business Combination
                        Table 9: Cost of Services to Help Workers Find New Employment              10
                          by Category




                        Page 20                            GAO/NSIAD-97-97 Defense Restructuring Costs
Contents




Table 10: Estimates of Paid Restructuring Costs and Experienced            15
  Savings by Business Combination




Abbreviations

AIA        Aerospace Industries Association
DCAA       Defense Contract Audit Agency
DCAP       Defense Conversion Adjustment Program
DCMC       Defense Contract Management Command
DDP        Defense Diversification Program
DOL        Department of Labor
DOD        Department of Defense
EDWAA      Economic Dislocation and Worker Adjustment Assistance
FAR        Federal Acquisition Regulation
UDLP       United Defense Limited Partnership


Page 21                            GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix I

Comments From the Department of Defense




             Page 22      GAO/NSIAD-97-97 Defense Restructuring Costs
                      Appendix I
                      Comments From the Department of Defense




Now on p. 3.




Now on pp. 3 and 4.




                      Page 23                                   GAO/NSIAD-97-97 Defense Restructuring Costs
                Appendix I
                Comments From the Department of Defense




Now on p. 5.




Now on p. 16.




                Page 24                                   GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix II

Comments From the Department of Labor




              Page 25     GAO/NSIAD-97-97 Defense Restructuring Costs
                            Appendix II
                            Comments From the Department of Labor




Now on p. 2.




Now on pp. 2, 13, and 14.




Now on p. 11.




Now on p. 11.




                            Page 26                                 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix II
Comments From the Department of Labor




Page 27                                 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix III

Comments From the Aerospace Industries
Association




Now on p. 3.




Now on pp. 3-4.




                  Page 28   GAO/NSIAD-97-97 Defense Restructuring Costs
                       Appendix III
                       Comments From the Aerospace Industries
                       Association




Now on p. 3.



Now on p. 3.




Now on p. 4.




Now on p. 5.




Now on pp. 3 and 16.




                       Page 29                                  GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix III
Comments From the Aerospace Industries
Association




Page 30                                  GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix IV

Major Contributors to This Report


                        John K. Harper
National Security and   Timothy J. DiNapoli
International Affairs   Paula J. Haurilesko
Division, Washington,   John D. Heere
                        Rosa M. Johnson
D.C.
                        George C. Burdette
Atlanta Field Office    Erin B. Baker


                        Ambrose A. McGraw
Los Angeles Field       Kenneth H. Roberts
Office                  Thaddeus S. Rytel, Jr.


                        Ruth A. Hijazi
San Francisco Field     Donald Y. Yamada
Office




(707219)                Page 31                  GAO/NSIAD-97-97 Defense Restructuring Costs
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